The move comes 10 months after King Gyanendra seized power after accusing the country's politicians of failing to end a violent Maoist insurgency. The agreement was announced on Tuesday - days after Nepalese political leaders met in the Indian capital, New Delhi.
The rebels have simultaneously announced they are ready to end years of violence and join the political mainstream. In an e-mail to media organizations, Maoist leader Prachanda said they are committed to ending the monarchy through what he called a "forward-looking political solution."
In Kathmandu, the head of the Center for Contemporary Studies, Lok Raj Baral, says there is widespread optimism at the prospect of a united political front emerging to fight King Gyanendra's rule.
"It is a polarization of all forces against [the] monarchy, and definitely it is not only a challenge but a threat to monarchy itself," he said. "All the forces are now together for a common cause, for the cause of democracy."
The political parties have made clear they will work with the rebels only when they abandon their arms. However, it is not clear how and when the rebels will surrender their weapons, or how the two sides will intensify their campaign against the king.
Domestic media reports say the Maoists would be willing to give up arms only under the supervision of the United Nations if elections are held. Rebel violence escalated after the king seized power, but has ebbed since the Maoists announced a unilateral three-month cease-fire in September.
The rebels have been fighting since 1996 to end Nepal's monarchy and establish a communist-run state. But in recent months, political parties say the rebels have indicated they would accept multiparty democracy.
The monarchist government says it is reviewing the agreement between the rebels and the political parties. Nepal has witnessed almost daily pro-democracy demonstrations in the streets of Kathmandu in recent months. But the king has tightened his grip on power, ignoring growing pressure from both inside and outside the country to return democratic rule to the tiny Himalayan country.